5/03/2010 @ 1:15PM

Latest Airline Marriage Probably Won't Be The Last

The all-stock merger between
Continental Airlines
and United Airlines parent
UAL
may not be the last word in this round of consolidation, as analysts say other carriers will need to “fly together,” in order remain profitable.

The merger, valued at just over $3.2 billion, will create the world’s largest global carrier, with combined annual revenue of $29 billion. Shareholders of
UAL
will receive 55% of the combined company, while their
Continental Airlines
counterparts will get 1.05 UAL common stock for each Continental shares they own, a consideration worth $23.34 at Monday morning’s prices.

Analysts at
UBS
think the companies will approach 10% of combined domestic capacity and about 2% of industry capacity that would provide a supportive pricing environment next year, and see upside potential for airline stocks on account of the deal.

That appeared to be the case Monday when Continental rallied 2.9% to $22.99, while shares of UAL were up 3.1% to $22.27.
Delta Air Lines
and
US Airways
were up 2.8% at $12.42 and 3.8% at $7.32, respectively. Smaller carriers were also moving higher, with
JetBlue Airways
shares up 2.5% at $5.73 and
Southwest Airlines
adding 0.5% at $13.25.

The United/Continental deal is expected close by the fourth quarter of 2010, pending shareholder and regulatory approval, and would create between $1 billion and $1.2 billion in annual synergies by 2013, including between $800 million and $900 million of incremental annual revenues. The combined company will have 10 hubs and serve more than 144 million passengers per year, leaving four network carriers to compete for domestic market share.

That is still too many, says Vaughn Cordle, chief analyst and managing partner at Airline Forecasts in Washington, D.C. Cordle thinks four network carriers will be unlikely to accomodate the higher industry costs in the future without consolidation. He projects fuel costs will be up $6.5 billion in 2010 compared with a year ago, and rise another $2 billion in 2011. Add to that another $2 billion in higher airport passenger facility charges and $4 billion to $6 billion in higher labor costs by 2014.

Cordle believes a merger between
AMR
, parent of American Airlines, and US Airways is imminent if both companies want to remain viable in an industry that produced an extra capacity of 7% in the past decade which led to $70 billion in net losses in 2009, or negative 5.7% in revenue.

With the merger of [United and Continental], the odds of liquidation and/or bankruptcy for US Airways and American increase because it will be too difficult, if not impossible, for them to remain viable as stand-alone businesses, Cordle wrote in a recent note.

Failure is not a good option for labor and other stakeholders, especially for shareholders and for smaller communities, which can only be served if there are profitable and large network airlines. The low-cost airline model operated by JetBlue and Southwest is not designed to serivce small destinations, Cordle says.

He expects the lower cost carriers will continue to nibble away some market share, from the network airlines, who have seen their market share shrink to 56% from 80% in a decade. By contrast, Southwest has grown its market share to 15%, from just 8%.

The industry in general needs to consolidate, agrees Helane Becker analyst at Jesup & Lamont Securities, noting that conditions are ripe for dealmaking. Companies have access to capital and can negotiate from a position of strength now that the economy is mending, Becker says.